Now that the election is over, many a taxpayer’s thoughts turn to year-end tax planning. Pundits are talking about changes to the tax code – and with change comes opportunity to save on taxes. Here are my Top 5 Year-End Tax Tips for 2016. There is a little something for everyone…
Tax Tip Number 1 – Accelerate Deductions, Delay Income
It is highly likely that under a Trump administration with party majorities in both houses of congress, a tax cut could come as quickly as next year. So, if you expect to be in the same, or a lower tax bracket next year, the optimal plan is to load up on deductions this year, and postpone taking income until next year. Here are some practical tips on how.
Charity begins on Schedule A
Many taxpayers put their money to good use by donating to the charity of their choice. This has a double benefit (i) you help a worthy organization make the world a better place; and (ii) Uncle Sam helps foot the bill in the form a tax deduction!
Real estate taxes
If you are like most homeowners with a mortgage, your monthly payments include money for real estate taxes. But those payments go into your mortgage company’s escrow account, not to the tax man. You can’t deduct those payments until your mortgage company sends the money to the taxing authorities. So, let your mortgage company know you want them to pay those taxes this year, not next year. Unfortunately, if you are subject to the Alternative Minimum Tax, this deduction won’t help you.
If you don’t have an IRA, but are eligible, set one up before year end. Be careful though; if you are a participant in a qualified plan, you may not be eligible to deduct IRA contributions.
If you are eligible to contribute to a traditional IRA, you get a triple tax benefit:
- a deduction reducing your taxable income;
- that same deduction also reduces your “Adjusted Gross Income” (known as “AGI”); and
- the earnings in the IRA account are not taxed until you make withdrawals.
For 2016, you can contribute up to $5,500 to your traditional and Roth IRA’s ($6,500 if you are over 50!). But those contributions cannot be more than your taxable compensation for the year. Thus, someone in the 10% tax bracket could save up to $550 in taxes ($650 if over 50) contributing to a traditional IRA.
By the way, reducing AGI (tax bene #2 above) is a big help. Some types of deductions are only allowed to the extent they are larger some a certain percentage of AGI. For example, only medical expenses that exceed 10% of AGI are deductible. So, the lower the AGI, the larger those deductions can be.
Medical Expenses – just what the doctor ordered
In prior years some people were not able to deduct medical expenses because they didn’t exceed the applicable percentage of their AGI (for 2016, the threshold is 10%, or if you or your spouse are over age 65 this year, the threshold is 7.5%). With rising medical costs, higher insurance premiums and larger co-pays/deductibles, this may be worth a second look for 2016.
Expecting a baby soon?
While tax planning should never override a health care decision, if your due-date is in early January, consider asking your doctor if it would be safe to induce before year end. Now hold on, don’t think of me as callous and calculating, let’s see how significant this can be for your growing family.
If you deliver this year, you can claim your new bundle of joy as a dependent on your 2016 tax return and get an extra $4,050 deduction! Even if you are in the lowest tax bracket (10%), that will save you an extra $405. Not only that, but you may be eligible for the Child Tax Credit – for 2016 the credit can be as high as $1,000 per child, but not more than your total tax liability. If your modified AGI exceeds a threshold level based on your filing status, the credit is reduced. Deliver this year and you could save $1,405 in taxes – that’s a lot of diapers! Check with your favorite tax advisor to see what tax bracket you will be in, and whether any of the tax credit phase-out rules apply to your situation.
Hit the Income Pause Button
For cash basis business owners, consider sending out invoices in January instead of December. Note: it is not kosher to receive a check this year and wait to deposit it next year. As far as the IRS is concerned, you had “constructive receipt” of the money; that is, you had power and control over it, and therefore it is taxable in the current year.
If you are an employee expecting a bonus near year end, see if your employer would be willing to delay paying it until January (but keep in mind they might want to take a deduction for that bonus this year, so don’t be surprised if they say no).
Tax Tip Number 2 – Dump the Dogs
If you have investments, now is a good time to review your portfolio and see if you have any unrealized losses (that is, any investments that are worth less than your tax basis). If so, you can sell now, and deduct the loss on your 2016 tax return, up to $3,000 (losses greater than $3,000 can be carried over to future years). By dumping those dog stocks now, you can at least take solace in knowing you’ve limited your losses, and may even get a tax break.
Tax Tip Number 3 – Get your refund now!
This is the perfect time of year to meet with your favorite tax advisor and estimate your current tax picture. If you are paid wages, you can reduce your income tax withholding by claiming more exemptions on IRS Form W-4 and give it to your payroll department. This will increase your take-home pay through the rest of this year. (Be sure to submit a revised W-4 in January and set your exemptions back to normal). Your favorite tax advisor can help you calculate how many tax exemptions to claim without winding up owing taxes on your return.
Tax Tip Number 4 – Use it or Lose It!
If you have a qualified flexible spending account at your place of work, chances are some or all of it must be used up by year end or it disappears. Check with your employer though, the IRS allows a grace period up to March 15, 2017, but only to the extent your employer’s plan allows it.
Tax Tip Number 5 – Avoid Penalties
Estimated Tax Penalty
Maybe you are not expecting a refund this year, maybe you expect to owe money instead. If so, you may need to make an estimated tax payment to avoid an underpayment penalty. What can I say? The IRS loves to add insult to injury, and kick a taxpayer when they are down. To avoid the penalty, you must pay in at least 90% of your total tax for this year, or 100% of the tax shown on last year’s return.
Even if you have income tax withheld from your wages, you may not have paid enough. This often happens when you have other substantial sources of income such as dividends, capital gains, or income from businesses you own. Get with your favorite tax advisor to see you need send Uncle Sam a little something extra to stay on his good side and avoid a penalty.
IRA Minimum Distribution Penalty
If you are over 70 ½ years in age by the end of this year, and you have a traditional IRA – read on. You must make minimum distributions from your traditional IRA before year end. If not, you face a draconian excise tax of 50% of the amount you should have withdrawn!
Note that Roth IRA’s do not have minimum distribution requirements. You might ask, how ‘bout I just convert my traditional IRA to a Roth? Not so fast – if you make that conversion, you must pay tax on every deductible contribution made into the traditional IRA; that could be way more expensive than the 50% excise tax.
Better to just make the minimum distribution. Bankrate.com has an on-line tool to help you calculate your minimum distribution, click here, but double check with your favorite tax advisor.
So, there you have it, my Top 5 Year-End Tax Tips for 2016. This just scratches the surface of tax planning for year end. In any event, you should not act or refrain from acting based on this article. Consult with your favorite tax advisor to find out what’s best for your specific situation.
I’m Ed, and I’m just sayin’…